After an organization reaches a certain size, dictated by the state they are based in, every business is required to provide workers compensation insurance for employees. But in an industry like remodeling, where risk of workplace injury is high, business owners must have proof that a subcontractor has workers compensation coverage and verify its validity—here’s why.

Workers compensation 101

Officers of any limited liability company or incorporation are required to cover all W-2 employees under a workers compensation policy. An officer may choose to either include or exclude him/herself on that policy. The most likely scenario for an officer to exclude him/herself from a workers compensation policy is if that individual worked solely out of an office, with low risk of injury and has health-care coverage to fall back on, since workers compensation only covers injury in the workplace.

Otherwise, workers compensation is not designed to cover an independent contractor who bills 1099. Those companies are required to carry their own workers compensation policies for its own employees.

In remodeling, if a subcontracted employee is not insured under an independent policy, a general contractor’s workers compensation policy not only covers an injury, but is also required to cover a subcontractor retroactively under his/her policy based on hours that person worked.

This is not always understood or practiced, and in the end, business owners are left to pick up the pieces, at a hefty cost.

Painful audits add protections

Mike Patterson, president of Patterson Builders-Remodelers LLC, based in Gaithersburg, Md., is a one-man shop, who relies on subcontractors to help him on jobs.

“I use a handful of subcontractors such as plumbers, painters, electricians,” he says. Most of them have been working with Patterson for years.

Being a one-man show and working with the same subcontractors, Patterson let his guard down. “I know everyone says never pay a sub without certificates on file, but I have,” he says.

Tracking down and verifying insurance certificates from subcontractors can easily be put to the side, except for when the insurance audit rolls around. Every year, Patterson sits down with an insurance auditor to verify insurance coverage and make sure premiums match the labor hours estimated in the beginning of the year.

Heightened enforcement

Since the recession, insurance companies have stepped up their enforcement policies related to business owners hiring uninsured subcontractors.

“Many companies witched employees from W-2 to 1099s to reduce employment overhead, and one of those expenses that was affected was a pleasant reduction in insurance costs. But when that happened, many of the subcontractors never got insured on their own, so by defautl were still unintentionally being covered under the GC’s policy,” Downs says.

According to Downs, insurance companies have had the right to charge for uninsured subcontractors for nearly two decades, yet choosing not to renew was not exercised as readily during the boom provided the carriers collected their retroactive premiums to which they were entitled—now it’s a very different story. He says if a business owner is caught once, or in some more generous situations, twice using insured subcontractors, the insurance companies will drop them.

Being dropped from an insurance company blacklists business owners and finding a new insurance company, which often means higher premiums.

And although any type of audit is not fun, Patterson’s insurance agent, Scott Downs, CRA, senior consultant at Downs & Associates Inc., based in Herndon, Va., says it may mean different things for different people, depending on the diligence of the business owner.

“Depending on your insurance carrier, if you’re paying more than $10,000 in premiums per year in workers compensation, you should expect to have a physical [in-person] audit annually,” Downs says. “Anything less than that, you will likely have a paper audit.”

During an insurance audit, business owners must provide their tax documents for all W-2 employees as well as 1099 subcontractors. For every subcontractor issued a 1099, an owner must have a valid certificate of insurance to accompany it—if a business owner cannot provide a valid certificate for every subcontractor, they will be charged retroactively by their insurance company for what it would have cost the carrier to cover the injuries that might have occurred.

They also may get penalized by their insurance companies for hiring uninsured subcontractors in the form of a premium increase or being dropped by the insurance provider altogether. According to Downs, the recession has caused insurance companies to crack down on their enforcement policies. (See Heightened Enforcement box)

Since insurance companies rely on individual history and risk level of the job (i.e. roofers have higher premiums than painters) to assign rates, they don’t like the risk associated with having to cover an unknown person. “The reason they will penalize you is because they don’t know anything about the safety practices of that subcontractor, and they’ve never been underwritten for experience or claims history—the only part of the risk they are aware of, and comfortable with, is the business owner who they originally agreed to cover,” Downs says.

Workers compensation is one of the most expensive types of insurance, and business owners are oftentimes left in shock when they find out how much it costs to cover an uninsured subcontractor, knowing there were no injuries during the year.

Power of proof of insurance

The audit can also raise attention in other critical areas such as the validity of a subcontractor’s insurance certificate, as in the case of Patterson.

Right before his insurance audit, Patterson was scrambling to track down a few outstanding certificates. “I asked one of my subs, and he said he would send it, and never did, so I just decided it would be easier to call the insurance company on his previous certificate,” Patterson says. After all, that subcontractor’s insurance provider hadn’t changed in the 10 years he was working with Patterson.

In the process of calling the insurance agent, Patterson learned that the subcontractor hadn’t renewed his policy in the last four years. “Turns out, he fell on hard times and had been forging certificates of insurance for years in order to save a few extra dollars,” he says.

Patterson was grateful the subcontractor hadn’t sustained injuries during that time, but he was left with a huge retroactive premium bill to pay for years’ worth of workers compensation.

He tried to collect money from the subcontractor who had defrauded him but never retained the total amount. “He paid me some of the money, but he didn’t have much,” Patterson says.

Still, had it not been for the audit, Patterson fears that he might not have caught on to the scam.

“It happens more than you would think, and you really have no way of knowing unless you verify with the company,” Patterson says.

Downs says that Patterson’s fraud case was both terribly unfortunate and extreme, yet not nearly as as common as business owners who simply never require a subcontractor to provide a current certificate of insurance or not being informaed of lapsed coverage due to a subcontractors payment issues.

Regardless of why or how, contractors need to verify insurance certificates before work begins, not after. Downs warns against leniency given to subcontractors with longstanding relationships with owners. His recommendations for business owners to protect themselves:

Before every job or payment to a subcontractor, you may request to see a current certificate of insurance with a valid date.

Include an additional insured clause as part of the subcontractor agreement, requiring a written notification of any policy cancellations from the insurance provider.

Lesson learned

Patterson learned even when you think you’re doing everything by the book, you can still get burned. Though not enjoyable, an insurance audit may lead to something much more important.

While insurance may feel like throwing away money when things are going well, remodeling is a high-risk industry, and there is no absolute when it comes to injury. “Those who have an appreciation for it [insurance] see the virtue of what it could do [in a time of need],” Downs says. —Morgan Zenner

If you’re unclear about the status of a worker, use the “20 Factor Test” issued by the IRS to determine whether workers are considered independent contractors or employees.

One year I was audited by workman’s comp six years afterwards. I did not have all certificates as described above. I contacted the Dept of Labor and explained this and thought the whole episode was resolved. Now 12 years later I have a bill with $3,000.00 in extra penalties and interest. Is there a statute of limitations on these assessments, fines, etc?